Conventionally, when a customer comes to a financial institution, such as a bank, to request a financial product, the bank determines the risk associated with the customer and, based on the risk, assigns a financing limit to the customer and an associated price for the financial product. For instance, in the case of a company seeking a loan or line of credit, a bank may determine the risk associated with that company and determine a borrowing limit and a price, such as an interest rate, based on annual accounts, interviews, projections etc. Periodically, usually annually, or when triggered by special circumstances such as a default, the bank may review the risk, financing limit, and/or financing price and adjust the financing limit and price according to the results of the review.
To obtain a financial product, such as a loan, insurance or the like, a customer typically phones or otherwise informs the bank (e.g., using an online application on the Internet) of the financing parameters and the type of financial product needed. For example, in the case of a funding product, the parameters usually include an amount and a maturity date. Alternatively, in the case of debt insurance products, the parameters usually include a debtor identity and an advance ratio.
A customer may reduce the cost of a financial product by structuring the transaction arrangement in certain ways. For example, if the customer pledges as collateral, or sells, assets to the bank, then the bank will generally discount the price of the financial product because the bank's risk and/or costs are lowered by the arrangement. A true sale structure, for example, lowers the bank's costs because the bank has a more direct claim on the assets without having to resort to legal proceedings and other expensive remedies should the customer go into bankruptcy.
In a similar fashion, financial protection may be received in the world of insurance or corporate assets. Based on the risk associated with the underlying assets, insurers set the price and limit for protection of the assets, and the insurance purchaser has to show adherence to certain requirements for the insurance to remain in force. Risk hedging products are also similarly obtained and priced. For convenience, the term “liability instrument” will generally be used herein to refer to funding products, insurance products, and hedging products, interchangeably.
Conventionally, after entering into a financial product arrangement, the provider distributes at least a portion of its obligations to third parties, thereby lessening its exposure to loss. For example, a bank may search for an investor to buy portions of loan(s) that it has originated, sometimes using specialized financing vehicles such as conduits or structured notes, among others.
Current conventional financing techniques, however, present several problems for both providers and customers. One problem for funding and insurance providers is that financial product arrangements are based on information that grows more “stale” or out-of-date as time passes. Relevant developments subsequent to entering into the arrangement are not reflected in the arrangement until a periodic, typically annual, review is held or until a review-triggering event, such as a past due payment, occurs. Ideally, a provider would like to modify the arrangement when the risk associated with the arrangement changes, which is a continuous phenomenon. For example, if the risk associated with a borrowing company goes up, a bank would like to immediately decrease the size of the company's funding line and/or increase the price (e.g., the interest rate) to ensure the financing arrangement achieves a positive marked-to-market return. Instead, current conventionally structured financial products allow the customer to fully draw under its credit line, regardless of any relevant recent changes in the customer's risk profile. Accordingly, it is desirable to update the price and/or terms of financial products automatically and in near real time based on the latest information regarding market and customer specific issues and based on any change in risk to the provider financial institution. It is also desirable to update the price and/or terms of financial products based on changes in the risk associated with the selling or servicing company underlying an asset.
A related problem for financing and insurance providers is low transparency or visibility into the business performance of a customer, which keeps risk-relevant changes hidden from the financial product provider. For example, conventionally, companies provide earnings and operations reports quarterly, (and most provide only annual accounts), so a provider may not receive relevant information until it is over three months to one year old. Moreover, quarterly reports are often un-audited and, therefore, not as reliable a source of information as the audited yearly report. In addition, different companies use different accounting and auditing methods to report earnings and status, especially those based in developing countries, making it difficult at best for a provider to directly compare information among a group of customer companies. Because of these differences, it is difficult for a provider to judging initial applications for granting loans or providing insurance and to administer ongoing arrangements. Accordingly, it is desirable for financial institutions to receive current information about customers on an ongoing, near real time basis, and to receive the information in a standardized form. It is also desirable to provide an incentive for customers to provide up-to-date information in a standard format, because customers often benefit from the current conventional arrangements and might otherwise be unwilling to change. It is also desirable that the current information be processed in near real time and effects resulting from the processing be incorporated into financial arrangements in near real time.
Another problem occurs when a company uses its equity for non-core business purposes, the results of which are outside the power of company management, such as investments in securities or other companies. Outside investments decrease the transparency of the company to financial product providers and increase the risk of losses that management has no power to avoid, yet which can destroy the value created by the company's core business. It is desirable to enable a company to sell such outside investments, or hedge the risk associated with them, so that investors may assess the company based on its core risk undertakings.
Yet another problem for financing and insurance providers is that the current conventional methods of analyzing credit risk are very difficult to automate. Due to the lack of information, human judgment is essential in the process of asset or company financing. It is desirable to create the ability to manage credit objectively, which may enable full automation of all evaluation and maintenance processes.
Customers of financing and insurance providers, which are typically corporate entities, also experience problems associated with current conventional finance and insurance arrangements. One problem for companies seeking financing or insurance is that current conventional arrangements and structures consider providing sale support financing (i.e., accounts receivable) as an expense, while receiving sale support financing from suppliers is considered to be free. This is a negative incentive to doing business, as a seller experiences an expense when financed sales are made, yet a buyer experiences no expense for purchasing stock using debt. It is desirable to reverse this effect, as this will provide incentives for buyers to lower inventory, pay for stock quickly, and utilize customer financing more strategically when it is needed. It is also desirable for companies to lock in a profit at sale time for an accounts receivable sale, to reduce the hedging cost of the profit, and to bring forward part of the profit.
A related problem for companies seeking financing or insurance is that it is difficult to raise capital by selling sale support financing (accounts receivable) assets to investors because the risk absorption and funding provisions desired by investors have different characteristics than those offered directly by sale support financing assets. It is desirable to create instruments having investor-desired characteristics based on sale support financing assets.
Yet another problem for companies seeking financing or insurance is the inefficiency of current conventional risk ratings. Conventional risk ratings are based on a banker's or other subjective assessment that is minimally transparent, at best. Therefore, once a year when a new subjective judgment is made the borrower may be faced with downgrade surprises. It is desirable for a borrower to each day understand the change in assessment and to have the ability to remedy any negative trends as soon as they set in. To enable this the subjective element of finance and insurance provision must be removed to the largest extent possible. It is desirable to provide fully objective finance and insurance provision to borrowers, including reporting in near real time to borrowers their current rating.
Another problem for companies seeking financing or insurance using current conventional products is that it is not possible or desirable to share capital and funding sources between companies without an intermediary, such as a bank, because sharing would release each company's confidential pricing and business volume information to the other company. It is desirable to confidentially share capital, funding sources, facilities, hedges, security programs and data among communities of corporations without using a costly intermediary and without revealing confidential information. Pooling assets from various companies into a portfolio increases diversification, which decreases the capital required and increases the efficiency of execution due to size effects, which decreases the cost of funds to the companies.
Another problem for companies seeking financing or insurance using current conventional products is that a company does not have available to it money equal to the value of its equity in the market. It is desirable for companies to issue or repurchase equity shares on a daily basis without diluting shareholding to optimize capitalization at every point in time with respect to these portfolios. It is also desirable for companies to have access to subordinated funding anonymously on a daily basis, which releases equity for other purposes. It is desirable to create such anonymous, flexible equity.
Yet another problem for companies seeking financing or insurance is “credit squeeze.” A fast-growing, successful company has financing needs that grow extremely quickly. Often, however, it cannot obtain the additional financing that it needs to grow and to service its previous financing because it reaches its financing limit. Thus, the company runs out of financing even though its current high-growth situation warrants additional financing. This situation often results in default on its earlier financing obligations. Accordingly, it is desirable to avoid credit squeeze by providing additional financing whenever assets are available to support the financing and by pricing the financing based on risk. It is desirable not to place limits on the amount of risk, but instead to appropriately price the risk that exists in near real time.
Yet another problem for companies seeking financing or insurance using current conventional products is that they cannot fully outsource the financing because minimum cost of funds cannot be guaranteed. It is desirable to provide a system in which financing can be completely outsourced, and a company can easily verify, control, and minimize the actual cost of funds, taking into account its other funding sources. It is also desirable to have near real time arbitrage of various sources of funds. It is desirable to provide objective assessment, which allows such verification and control.
Yet another problem for companies seeking financing or insurance is the difficulty of obtaining capital and funding in bad economic times and the excessive ease in good times, regardless of changes in the quality of the underlying value drivers in the company, such as the quality of ideas and persons and the ability to provide labor, among others. Companies are at the mercy of the large amount of systemic risk in the current financial system, exemplified by the economic or business cycle. The business cycle systemic risk is exasperated by losses and gains that do not quickly materialize and become known to the market due to the financial system, accounting rules, and the legal system. In addition, the market typically reacts to events, such as declared losses or declared reductions in profitability, with price swings more excessive than the events dictate. It is desirable to increase non-systemic volatility, i.e., allow individual companies to be more volatile, if doing so will decrease systemic volatility, i.e., make the economy less volatile. Near real time transparency and objectivity will help realize this goal.
Investors in securities and instruments based on financing and insurance arrangements also experience problems associated with the current conventional arrangements. One problem for investors is the inconsistency of risk management of the assets underlying such securities and the lack of transparency of the risk management process. Another investor problem is the lack of standardized value measurement for such securities.
Similar to the world of securitization, it is desirable to provide a common basis for assessing the risk and the return of transactions without the need to use subjective assumptions or analysis. In addition it is desirable to provide the ability to optimize and execute such transactions in near real time by making such transactions objective.
Similar to the world of mutual funds, it is desirable to enable asset investment whereby both the asset and liability providers have the ability to bid and sell or invest in near real time, removing the need for a fund manager and increasing the efficiency of determining the investment appetite and sale appetite of all parties involved.